Bad Times, Good Money

It is unwise to be too sure of one's own wisdom. It is healthy
to be reminded that the strongest might weaken and the wisest
might err. - Mahatma Gandhi

Today, we will not pick on the Fed chairman. We promise. Cross
our hearts and hope to die.

We are moving on. The chairman will get whatever the Fates have
prepared for him. God help him.

But the evil that men do lives after them. As the Caesar of central
banking continues towards his reward, the world's financial system
lunkers on too - towards correction.

"For the first time since WWII, the world is in the grips
of a synchronized global economic downturn," writes Dr. Kurt
Richebacher. "We are looking for financial turmoil in the
United States of a gravity without precedence in the whole postwar
period."

Greenspan spent the last 16 years puffing up not only his own
reputation, but also the biggest credit bubble ever.

Not that we have any special information on the subject, but we
take it for granted that what inflates is also subject to deflation.
Central banking in the time of Greenspan became such a popular
sensation that it seemed to many that it was a permanent success.
The Greenspan Fed had increased the supply of credit more than
all the Fed chiefs and Treasury secretaries back to the time of
Washington. Nobody complained, as the 'inflation' went directly
into stock prices. It began to look as though the science of central
banking had been mastered, and the business cycle had been brought
to heel too. For, had not Greenspan proven that he could increase
credit without triggering inflation? And didn't that give him the
ability to head off a recession by cutting rates quickly?

But nothing fails like success. Or, as economist Hyman Minsky
pointed out, nothing can be more de-stabilizing for an economy
than a long run of macro-economic stability.

American entrepreneurial capitalism, combined with enlightened
Greenspan central banking, seem to have taken the risk out of stocks
and paper money. The Fed seemed capable of managing both for the
benefit of long-term investors. Is it any wonder they bought and
borrowed when it made sense - in the '80s - and continued to buy
when it didn't - in the '90s?

Both the credit bubble and Mr. Greenspan's own bubble reached
their zenith about a year ago, by our reckoning. Both now seem
to be losing gas.

Gold hit its lowest point since the early '70s about the very
same time that Mr. Greenspan's stock seemed to peak out, with the
appearance of "Maestro", Bob Woodward's insipid hagiography
of the Fed chairman, in November of 2000.

Mr. Greenspan had become the biggest news story in the entire
world. Sure, there were probably a few primitives in fishing villages
in the New Hebrides who had never heard of the man. But to the
world's intelligentsia economica, the chairman of the Federal Reserve
system was 'household,' as well known as Ronald McDonald, Cher
or Jim Beam.

On the day the book came out, you could have bought an ounce of
gold for $264. But it would have cost you $11,152 to buy the whole
Dow. That was a big change from the late '70s. Then, the Dow and
an ounce of gold changed hands for about the same price.

But since the book "Maestro" appeared, the Maestro himself
has been in a bear market. More and more often you see him criticized
in the press. Unlike Kozlowski and Blodget, he has not been blamed
for stock market losses - yet. But the longer the slump continues...and
the closer the U.S. economy edges towards deflation... and the
more stock prices fall...the more people will wonder about the
curious bubble the Fed chairman wrought.

Mr. Greenspan's stock does not trade publicly and is not quoted
on any exchange. But Daily Reckoning readers may still profit as
it goes down. Gold is the nemesis of managed currencies. It is
what investors turn towards when they lose faith in the managers.
Since the appearance of "Maestro," the price of gold
has risen 20%. The Dow has fallen nearly 30%. These are trends
we expect to continue at least until Mr. Greenspan's reputation
is fully corrected.

"Gold is heading for $1,000," writes my old friend Martin
Spring. Over the last 12 months gold has risen 15% against the
dollar. Gold mining stocks, after taking a beating this past summer,
are back up about 40% since January.

"In recent years," Martin continues, "there's been
an almost-perfect negative correlation between US shares and the
gold price...which means that if Wall Street continues to fall,
it's almost certain bullion will rise."

Martin notes that global demand is currently exceeding mine and
recycling production by about 400 tons a year. So little money
was spent on new exploration and mine development in the last decade,
production will probably fall further, until the price of gold
hits $400 - $500 an ounce, high enough to encourage additional
investment...

But why would gold go up in a general price deflation?

"Gold can also prove to be a good defensive investment in
deflationary times, as it was in the '30s," Martin explains. "Over
the past three years the bullion price has risen 23% despite a
fall in inflation both actual and anticipated by the markets (as
shown by the declining differential between the yields of fixed
and inflation-protected government bonds.)"

Gold is real money, after all. It is decent money when Fed chiefs
prosper. It is even better when they don't.

Bill Bonner is the founder and editor of The Daily Reckoning.
He is also the author, with Addison Wiggin, of The Wall Street Journal best
seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century
(John Wiley & Sons).

In Bonner and Wiggin's follow-up book, Empire of Debt:
The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor
to expose the nation for what it really is - an empire built on delusions.
Daily Reckoning readers can buy their copy of Empire of Debt at a discount
- just click on the link below: